When private companies are less productive than government contractors

Governments in high-income countries around the globe have increasingly outsourced development work to private businesses. Nowhere has this trend been more pronounced than in the US. Could this be the reason that research productivity has declined?

I know it sounds weird to say that outsourcing to private companies has contributed to the decline in research productivity we have seen for decades. Aren’t government entities and government contractors supposed to be less efficient than private businesses? Isn’t it a matter of faith that the private sector can do everything better, faster and cheaper than the government can?

Well, not everything it seems. At least when it comes to research and development, government entities and government contractors seem to be more effective and productive than private businesses.

For decades now, the US government has reduced its spending on development work while keeping spending on fundamental research at roughly constant levels relative to GDP. Crucial development work is now done in the private sector and only once a commercially viable product is available, does the government step in and buy the product for its purposes. Just think of Elon Musk’s SpaceX which has developed its Falcon 1 rocket independently and is now counting NASA and the US Department of Defence as its main customers.

US Government spending on research and development as share of GDP

Source: Knott et al. (2023)

Most people (including me) would argue that SpaceX probably developed its spacecraft and launch capabilities faster and cheaper than NASA could, but after reading a new study by Anne-Marie Knott and her collaborators I am not so sure anymore.

After all, SpaceX is currently developing its Starship rocket that should enable a return to the moon and possibly bring people to Mars. These rockets are developed at a cost that is 30 times less than NASA’s own Space Launch System (SLS). And the cost per launch of NASA’s SLS is expected to be 1,000 times that of SpaceX Starship. But at least NASA’s SLS seems to work (it had a successful unmanned launch in 2022) while SpaceX is yet to launch a Starship without obliterating it at one point during the flight or another.

I am not an expert in the SpaceX vs. NASA debate, so I don’t know if SpaceX will manage to develop its rockets more efficiently than NASA. But at least when it comes to the average private developer vs. the average government contractor, there seems to be an advantage for government contractors.

The chart below shows the research and development productivity of companies that are entirely financed by the private sector vs. the productivity of companies that do R&D work with government financing. As the chart shows, government contractors are systematically more productive than private businesses.

R&D productivity of private companies vs. government contractors

Source: Knott et al. (2023)

The researchers do not know why government-funded R&D is more productive than privately funded R&D, so the driver of this result remains mysterious for now. But if you ask me, one reason could be that governments tend to have a longer time horizon and are more patient than private businesses are. And when it comes to developing new technologies, patience is a key ingredient to success.